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Supreme Court Issues Decision on IRS Summons Enforcement

On
Thursday, the U.S. Supreme Court vacated and remanded a
decision of the Eleventh Circuit, in which the appeals court
held “that a bare allegation of improper purpose [in issuing a
summons] … entitle[s] a taxpayer to examine IRS officials” (Clarke, No. 13-301 (U.S.
6/19/14), slip op. at 1). Instead, the Court directed the
Eleventh Circuit to consider on remand whether the taxpayer
has “pointed to specific facts or circumstances that plausibly
raise an inference of improper motive” (id.). The unanimous
decision explained that every other court of appeals has
rejected the Eleventh Circuit’s view.

The summons
dispute arose in connection with an IRS examination of the tax
returns of Dynamo Holdings Limited Partnership for 2005 to
2007, during which the IRS was focusing on large interest
expenses for those years. Although Dynamo agreed twice to
extend the statute of limitation during the exam, it refused
the third request. After the refusal, the IRS issued summonses
to four individuals who the IRS believed had information about
Dynamo, none of whom complied with the summonses. The IRS also
issued a final partnership administrative adjustment (FPAA),
proposing changes to Dynamo’s tax returns for the years at
issue. Dynamo challenged the FPAA in Tax Court, and that
proceeding is still pending.

When the IRS issued a
summons enforcement action in federal district court, Michael
Clarke, who had been Dynamo’s chief financial officer,
objected that the summonses were issued for improper purposes.
The two improper purposes he alleged were that (1) the
summonses were issued in retaliation for Dynamo’s refusal to
extend the statute a third time and (2) they were issued,
after Dynamo had filed suit in the Tax Court, to evade the Tax
Court’s limits on discovery.

The district court
rejected Clarke’s allegations, holding that his allegation
that the summonses were issued in retaliation for the refusal
to extend the statute of limitation was “mere conjecture,” and
pointing out that the second theory failed as a matter of law
because the validity of a summons must be tested when it is
issued and Dynamo had not yet commenced its Tax Court case
when the summons was issued. The Eleventh Circuit, however,
reversed the district court and held that, under its
precedent, “a simple ‘allegation of improper purpose,’ even if
lacking any ‘factual support,’ entitles a taxpayer to
‘question IRS officials concerning the Service’s reasons for
issuing the summons’” (Clarke, slip op. at 5 (citations
omitted)).

As the Supreme Court explained, the
Eleventh Circuit’s holding was overbroad and conflicted with
precedent in all the other circuits. The Court held that a
taxpayer has a right to conduct an examination of IRS
officials regarding their reasons for issuing a summons, but
only when the taxpayer points to specific facts or
circumstances plausibly raising an inference of bad faith. The
Court explained that, “Naked allegations of improper purpose
are not enough: The taxpayer must offer some credible evidence
supporting his charge.” However, the Court further stated that
circumstantial evidence can be used to meet this burden
(Clarke, slip op at 6).

In its remand order,
the Supreme Court gave the Eleventh Circuit instructions on
the deference it should give to the district court’s opinion
in its reconsideration of the case. The Court explained that
the district court’s decision was entitled to deference, but
only if it is based on the correct legal standard, and that
the district court’s latitude did not extend to “legal issues
about what counts as an illicit motive” (Clarke, slip
op. at 8).

With all the recent tax law changes, this year it’s more important than ever to make sure your clients’ tax situations are squared away before year end. This report provides necessary guidance to ensure 2019 starts without a hitch.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.